PILLAR 1 OF THE BASEL II FRAMEWORK ALLOWS BANKS TO USE VARIOUS APPR...

Question

2.

Pillar 1 of the Basel II framework allows banks to use various approaches to calculate the capital requirements

for credit risk, operational risk and market risk. Which of the following Basel II approaches allows a bank to

explicitly recognize diversification benefits?

a.

The internal models approach for market risk

b.

The internal ratings based approach for credit risk

c.

The basic indicator approach for operational risk

d.

The standardized approach for operational risk

Correct Answer: a

Rationale:

The internal models approach allows banks to use risk measures derived from their own internal risk

management models, subject to a set of qualitative conditions and quantitative standards. In terms of risk aggrega-

tion within market risk, banks are explicitly allowed to recognize empirical correlations across broad market risk

categories, and, thus, diversification benefits.

Section: Operational and Integrated Risk Management

Reference:

“Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised

Framework—Comprehensive Version,” (Basel Committee on Banking Supervision Publication, June 2006).*

John Hull, Risk Management and Financial Institutions, 3rd Edition, Chapter 12, “Basel I, Basel II and Solvency II.”

Learning Objective:

Describe and contrast the major elements—including a description of the risks covered—of the

two options available for the calculation of market risk: Standardised Measurement Method and Internal Models

Approach.

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in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc.

2015 Financial Risk Manager (FRM®) Practice Exam